Sometimes the cure is worse than the ill: an occasional look into the life of LSE DESTIN 2010

Why Saudi Arabia Fails?

Saudi Arabia’s Failure. 60% of Saudi population is under the age of 21 and 40% of Saudis between the age of 20 and 24 are unemployed[1]: unemployment is a problem of great scale in Saudi Arabia. When the government imposed Saudi business to fill their positions with at least 30% of Saudis, businessmen remarked that Saudis are just not qualified enough: an incompetent and ultraconservative educational system was not tailored to equip Saudis with job skills. Unemployment is a structural feature which cannot be brushed off by ad hoc measures: it is the results of the absence of an industrial base able to generate jobs and the concomitant widespread use of cheap foreign labor. Why Saudi Arabia which is endowed with some of the most abundant supply of oil is unable to offer prosperity for its population? One of the possible answer is that Saudi Arabia does not have in place inclusive political institutions such as rule of law and representative governments which can ensure the participation of the population at large towards the progress of the society. Repressive political institutions feeds into extractive economic institutions in which few extract a surplus at the expenses of the majority of the population. These institutions can be traced back to the years in which Saudi Arabia was formed.

US-Saudi Arabia Deal (source cartoonstock.com)

Institutions as Primary Source of Prosperity? In 1930 Ibn Saud, the ruler of what was to become Saudi Arabia, saw the influx of pilgrims to Mecca drastically reduced as a result of the Great Depression. To counter the shortfall in funds, he started negotiations with the Standard Oil Company of California (now Chevron) to sell the right to Arabian oil. When the first concession was granted in 1933 the newly formed company Arabian-American Oil Company ARAMCO agreed to pay the oil royalties not to the Saudi state but to a single household, that of the king Ibn Saud. The political economy of oil in Saudi Arabia was forged with the aim to preserve oil security. As in Saudi Arabia, oil companies’ modus operandi was to pay directly governments of oil producing countries to ensure the regime’s complacency for their operations. When in the late 1950s ARAMCO offered to increase the government’s share in oil rent, the minister of petroleum Abdallah Tariki surprisingly turned down the offer. More money, he argued, would have been squandered in extravagancy and only financed the luxury of the royal house while leaving Saudi people pauperized as had been the case until that point. He made a case for building a series of institutions which could ensure that oil money could fuel the prosperity of the country at large and not only of one kin group:

(he) rolled out the blueprints for the institutions that might make a difference: writing a constitution, electing representative to a national parliament, building industry, investing seriously in human capital formation, expanding the ranks of Saudis with advanced degrees, and taking over ARAMCO in stages. [2]

Tariki’s proposals for political and social reforms never saw the light. The movement of reformers of which he was part in the late 1950s was sidelined and evicted from power by a more conservative movement within the royal family: Saudi Arabia never shifted from an absolute monarchy to more representative forms of government. It therefore was never equipped with institutions which could ensure the access of broad segments of the society to the decision making process. Absolutism and rule by decree substituted the rule of law, representative parliament and an independent judiciary power. Such political institutions in turn crystallized extractive economic institutions in which the oil revenues enriched only the ruling clique at the expenses of the rest of the society[3]. In the early 1950s, the oil economy propelled other ancillary economic activities such as construction, supply of electric power and trade to serve the foreigners in coastal towns: oil in a very limited sense modernized the country, yet oil and other complementary economic activities remained the exclusive domain of the ruling family and of an handful of private businessmen and contractors [4].

Seen from this angle, the thesis is therefore as follows: Saudi Arabia failed to create prosperity for large segment of its population because of extractive political institutions which ensured that the oil profits swell the pockets of the rulers. The decisive factor is therefore the institutions and not the oil revenues: the former dictate how the latter are to be used. Next post will dissect this argument and analyze whether institutions can conclusively be held as primary source of prosperity.

[2] America’s Kingdom. Mythmaking on the Saudi Oil Frontier by Robert Vitalis p.168

[3] “In 1949 the king received around $90 million, paid mainly in gold; it is estimated that by November 1950 he received another $70 million. Officially these funds go to “raise the living standards” of his people; in fact all but 10 percent, which he pays mainly to tribes to keep them quiet, goes into the bottomless pockets of the king, his immediate family and entourage”. The Economist quoted in Vitalis p. 131

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